The Price–Yield Seesaw
When market interest rates rise, older bonds fall in price. Use a seesaw to see the most important rule in bonds.
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Text version · Bonds & Fixed Income, lesson 2: “The Price–Yield Seesaw”
When market interest rates rise, older bonds fall in price. Use a seesaw to see the most important rule in bonds.
Rates go up, prices come down
Market interest rates (yield) and bond prices always move in opposite directions: when one end goes up, the other comes down.
Price = present value of future cash flows
Every future dollar “shrinks” when brought back to today; that's its present value. The higher the rate, the more it shrinks, and the lower the price.
Premium, par, discount
When market rates are below the coupon rate, the older bond is more attractive and trades above face value, at a premium; when they're equal, it trades at face value; when market rates are higher, it trades below face value, at a discount.
Key takeaways
- Bond prices and yields move in opposite directions.
- When market rates are above the coupon rate, the bond trades at a discount; below it, at a premium; equal to it, at face value (par).
- Price = the sum of all future cash flows discounted at the market rate.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Example”: when an older 3% bond meets a 5% market rate, does its price rise or fall?
- Drag the market rate from 5% to 7%: which way does the seesaw tilt? Does the badge say premium, par or discount?
- Now drag the rate down to 3%: why does your older 5% bond get bid up above $1,000?
- Drag the marker along the curve: each time rates rise 1%, does the price fall by the same amount?
Quiz and explanations
- 1. You hold a bond with a 3% coupon rate and market rates rise to 5%. Its price will…
- Answer: Fall.New bonds pay 5% and the old one only 3%, so it has to get cheaper to find a buyer.
- 2. What's it called when a bond trades below face value?
- Answer: Discount.Price < face value means a discount.
- 3. A bond with 1 year left pays $1,050 once at maturity ($50 coupon + $1,000 principal). Market rates rise from 5% to 10%. Roughly what's its price now?
- Answer: $954.55.$1,050 ÷ 1.10 ≈ $954.55. At 5% it was $1,050 ÷ 1.05 = $1,000.
Terms in this lesson
- yield (Yield): The annual return you'd earn buying a bond at its current price; the lower the price, the higher the yield.
- discount (Discount): A price below face value, which happens when market rates are above the coupon rate.
- face value (Face Value): The principal a bond repays at maturity, commonly $1,000.
- premium (bond) (Premium): A price above face value, which happens when market rates are below the coupon rate.
- present value (Present Value): What a future amount of money is worth today after discounting at an interest rate.